What’s Your Tax Issue? – Renting Out Your Home

The Tax Issue:

I live in Ontario and own a house.  I’m thinking about renting out the house (to supplement my income).  I bought the house in 1986 with my then-husband for $85,000, both of our names were on the deed.  We separated in 2006 with me remaining in the house; then divorced in 2008 at which time I ‘bought him out’ of the house resulting in the house being solely in my name.  The house is currently valued at approx. $260,000.  If I move out, rent it out, then decide to sell it within 1-5 years, how do I calculate the tax I would owe re capital gains?

The Answer:

Your question actually has three “tax events” happening so it’s a good exercise for a 2nd year tax student like me (as I was at the turn of the century 🙂 ).

First, you bought out your husband at the time of your divorce. I’m not sure about the circumstances, but the general rule here is that regardless of the actual price you paid, your husband’s share of the original cost became your cost for tax purposes unless, at the time, you both elected on your tax returns to apply the actual price you paid.

Second, at the time you decide to move out and rent the property, there is “change of use”, which would normally result in a deemed disposition at fair market value. Since the house is your principal residence, your gain is tax-exempt.

Third, once the change of use has occurred, any future increase in value might be taxable when you sell the house. There is a special election you can make under section 45(2) of the Income Tax Act that will allow you to avoid the change in use rules and treat the property as your principal residence for up to 4 years. In order to benefit from this concession, you cannot claim depreciation during the time you rent the property. If you sell the house within the 4-year limit after making the election, then the full amount of the gain will be exempt as a principal residence. However, if you sell after the four years, then the full amount of the increase in value from the time you moved out will be taxable as a capital gain.

WHAT’S YOUR TAX ISSUE?

This is the first instalment of a regular feature on The Tax Issue where you ask the questions and I offer an incredibly coherent and entertaining answer. This week, the topic is marriage  breakdown and the equivalent-to-spouse credit.

The Tax Issue:

Upon the breakdown of a marriage, who is eligible to claim an equivalent-to-spouse credit for a child that lives with both parents on a regular basis throughout the year?

The Answer:

This is a question that comes up on a regular basis, and the answer is a bit complicated.

First, let’s look at who can claim the equivalent-to-spouse credit. You must fall into one of the following categories at any time in the year:

  1. You must be unmarried and not in a common-law relationship; or
  2. You are married or in a common-law relationship, but did not support or live with your spouse or partner and your spouse or partner did not support you.

Now, let’s look at who would be the subject of the claim. The person must be someone who lives with you and is:

  1. Resident in Canada (except in the case of your child)
  2. Wholly dependent on you for support
  3. Related to you (we’re talking immediate family)
  4. Except in the case of a parent or grandparent, under 18 years of age, or dependent on you by reason of mental or physical infirmity.

Now that we’ve covered the basics, let’s get down to the actual question. Let’s assume we are talking about a child under 18, the parents separate in the year and the father immediately begins making non-deductible support payments pursuant to a court order or written agreement.

Essentially, the answer depends on whether we are in the year of the breakup or a subsequent year.

In the year of breakup:

In this year, either parent who qualifies can claim the deduction in respect of the child, but they cannot share the credit. So, if the child normally lives with both parents (shared custody), then they must agree as to who will take the credit in respect of the child. If they can’t agree, then neither one gets the claim.

If there are two children, and each spouse wishes to make a claim for one child, this might be possible, but each parent would have to prove that their respective child lived with them and was wholly dependent on them for support at some time in the year.

After the year of breakup:

In any subsequent year, the person required to make child support payments (whether or not the payments are actually made) is not entitled to the claim. So, in our example, the mother would be the only person eligible to make the equivalent-to-spouse claim in respect of the child.

If no support payments are being made, or they are paid but are not required under a written agreement or court order, then the above restriction does not apply, and either parent can make the claim, as long as they meet the criteria set out above.